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The Human
Network Effect
Cisco Systems, Inc.
2008 Annual Report

Table of contents

  • Page 1
    The Human Network Effect Cisco Systems, Inc. 2008 Annual Report

  • Page 2
    ...Fiscal Year '04 '05 '06 '07 '08 Consolidated Statements of Operations Data (in millions, except per-share amounts) Years Ended July 26, 2008 July 28, 2007 July 29, 2006 Net sales Income before provision for income taxes Net income Net income per share-diluted $ 39,540 $ 10,255 $ 8,052 $ 1.31...

  • Page 3
    ...globally. That's the Human Network Effect. Introduction 1 Letter to Shareholders 12 Reports of Management 16 Report of Independent Registered Public Accounting Firm 17 Selected Financial Data 18 Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Quantitative and...

  • Page 4
    ... employees remote, highly secure access to customers, resources, and the network so they can connect and collaborate from more places-and get more done. VIRTUAL WORKPLACE Call Management Software Wireless Phones and Access Points Network Foundation with Built-In Security Unified Communications...

  • Page 5
    ... clinicians gain easy and fast access to patient records, imaging, and the healthcare resources they need right now. Video Conferencing Unified Communications Imaging Systems Content Delivery Networks Electronic Health Records Wireless Connectivity 4 Cisco Systems, Inc. 2008 Annual Report 5

  • Page 6
    ...'Smart Building,' which saves energy and has no cubicles." / "For improving collaboration, saving resources, and getting more done?" / "Exactly. And I ended up reducing my carbon footprint today." / "Says who?" / "The office manager...and the bus driver." 6 Cisco Systems, Inc. 2008 Annual Report 7

  • Page 7
    ... Wireless Connectivity Safety and Security Virtual Classrooms Administrative Efficiency Unified Communications Jumpstart Learning Create a learning environment that's fully centered on students and matches what they'll encounter in the outside world. Content Delivery Networks 8 Cisco Systems...

  • Page 8
    ... our customers' needs better, we save them time, and we give them confidence." / "So it improves the experience of everyone who sets foot in your branch?" / "And online, and at home, and at the ATM." / "Customer satisfaction, all day and all night!" 10 Cisco Systems, Inc. 2008 Annual Report 11

  • Page 9
    ... the best solutions to meet their needs. Innovation is at the foundation of Cisco culture. In fiscal 2008, we brought more than 250 new products to market, including the Cisco Nexus switches and the aggregation services routers. Cisco TelePresence systems continue to gain market share and exemplify...

  • Page 10
    ... provider of web-based business intelligence and analytics reporting solutions focused on contact centers; Nuova Systems, Inc., a developer of next-generation products for the data center market; Securent, Inc., a leading provider of policy management software for enterprises; Navini Networks, Inc...

  • Page 11
    ... so that our affairs are conducted to the highest standards of personal and corporate conduct. Management also has established an effective system of internal controls. Cisco's policies and practices reflect corporate governance initiatives that are compliant with the listing requirements of NASDAQ...

  • Page 12
    ... our opinions. As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for uncertain tax positions in 2008. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of...

  • Page 13
    ... and $836 million, net of tax, during the respective years. There was no employee share-based compensation expense under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), prior to fiscal 2006 because the Company did not adopt the recognition...

  • Page 14
    ... any forward-looking statements for any reason. Overview We sell Internet Protocol (IP)-based networking and other products and services related to the communications and information technology industry. Our products and services are designed to address a wide range of customers' business needs...

  • Page 15
    ... sales discounts, rebates, and product pricing. Operating expenses in fiscal 2008 increased in both absolute dollars and as a percentage of revenue compared with fiscal 2007, primarily as a result of increased headcount-related expenses. The effects of unfavorable foreign currency exchange rates...

  • Page 16
    ... assured. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer's payment history. In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred...

  • Page 17
    ...29, 2006 Employee share-based compensation expense Share-based compensation expense related to acquisitions and investments Total $ 1,025 87 $ 1,112 $ 931 34 $ 965 $ 1,050 87 $ 1,137 The determination of fair value of share-based payment awards on the date of grant using an option-pricing model...

  • Page 18
    ... of stock price returns, which affect expected employee exercise behaviors, and are based on our stock price return history as well as consideration of various academic analyses. Because share-based compensation expense recognized in the Consolidated Statements of Operations is based on awards...

  • Page 19
    ...lapses in the R&D tax credit laws; by transfer pricing adjustments including the postacquisition integration of purchased intangible assets from certain acquisitions into our intercompany R&D cost sharing arrangement; by tax effects of nondeductible compensation; by tax costs related to intercompany...

  • Page 20
    Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Data for Fiscal 2008, 2007, and 2006 Net Sales The following table presents the breakdown of net sales between product and service revenue (in millions, except percentages): Years Ended July 26, 2008 ...

  • Page 21
    ...amortization of acquisition-related intangible assets and employee share-based compensation expense. We do not allocate these items to the gross margin for each theater because management does not include the information in measuring the performance of the operating segments. 26 Cisco Systems, Inc.

  • Page 22
    ..., system, or solution, among other factors. In addition, certain customers tend to make large and sporadic purchases and the net sales related to these transactions may also be affected by the timing of revenue recognition. Net Product Sales by Theater United States and Canada Net product sales in...

  • Page 23
    ... we acquired during the fourth quarter of fiscal 2007, and due to sales of IP phones and associated messaging, conferencing and contact center software as our customers continued to transition from an analog-based to an IP-based infrastructure. • Sales of video systems, which include solutions and...

  • Page 24
    ... from module and line card sales related to our routers and LAN switches as customers continued to emphasize network security; and revenue from sales of our next-generation adaptive security appliance products, which integrate multiple technologies, including virtual private network (VPN), firewall...

  • Page 25
    ... the service provider market, price and product competition in the communications and information technology industry, introduction and market acceptance of new technologies and products, adoption of new networking standards, and financial difficulties experienced by our customers. We may, from time...

  • Page 26
    ..., 2008 July 28, 2007 Cost of sales-product Cost of sales-service Employee share-based compensation expense in cost of sales Research and development Sales and marketing General and administrative Employee share-based compensation expense in operating expenses Total employee share-based compensation...

  • Page 27
    ... of Financial Condition and Results of Operations Our methodology for allocating the purchase price, relating to purchase acquisitions, to in-process R&D is determined through established valuation techniques. See Note 3 to the Consolidated Financial Statements for additional information regarding...

  • Page 28
    ... for Fiscal 2008, 2007, and 2006." Net Sales The increase in net product sales primarily occurred across our four largest geographic theaters as we experienced increased information technology-related capital spending by our customers in our service provider, enterprise, and commercial markets. The...

  • Page 29
    ... due to module and line card sales related to our routers and LAN modular switches as customers continued to emphasize network security, and also due to sales of our next-generation adaptive security appliance product, which integrates multiple technologies including VPN, firewall, and intrusion...

  • Page 30
    ...due to an increase in headcount-related expenses. Scientific-Atlanta contributed an additional $86 million of sales and marketing expenses for fiscal 2007 compared with fiscal 2006. Sales and marketing expenses for fiscal 2007 included employee share-based compensation expense which decreased by $35...

  • Page 31
    ... favorable foreign tax audit settlement that occurred in fiscal 2006. For a full reconciliation of our effective tax rate to the U.S. federal statutory rate of 35% and further explanation of our provision for income taxes, see Note 13 to the Consolidated Financial Statements. 36 Cisco Systems, Inc.

  • Page 32
    ...U.S. Securities and Exchange Commission (SEC) announced that they will issue for comment a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting...

  • Page 33
    ...), accounts receivable collections, inventory and supply chain management, excess tax benefits from share-based compensation, and the timing and amount of tax and other payments. For additional discussion, see "Part I, Item 1A. Risk Factors" in our Annual Report on Form 10-K. Accounts Receivable...

  • Page 34
    ... to customers. Manufactured finished goods consist primarily of build-to-order and build-to-stock products. Service-related spares consist of reusable equipment related to our technical support and warranty activities. All inventories are accounted for at the lower of cost or market. Inventory is...

  • Page 35
    ... the acquisition of Scientific-Atlanta and for general corporate purposes. The 2011 Notes and the 2016 Notes are redeemable by us at any time, subject to a make-whole premium. In fiscal 2008, we terminated $6.0 billion of interest rate swaps that we had entered into in connection with the issuance...

  • Page 36
    ... in our operating results, shipment linearity, accounts receivable collections, inventory management, excess tax benefits from share-based compensation, and the timing and amount of tax and other payments. As a result, the impact of contractual obligations on our liquidity and capital resources in...

  • Page 37
    ... the tax benefit related to employee stock incentive plans are recorded as an increase to common stock and additional paid-in capital. As a result of future repurchases, we may report an accumulated deficit as a component in shareholders' equity. Liquidity and Capital Resource Requirements Based on...

  • Page 38
    ..., the financial condition and near-term prospects of the investee, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. Fixed Income Securities At any time, a sharp rise in interest rates or credit spreads could...

  • Page 39
    ...in private companies is based on the fundamentals of the businesses, including, among other factors, the nature of their technologies and potential for financial return. Long-Term Debt During fiscal 2008, we terminated $6.0 billion of interest rate swaps that we had entered into in connection with...

  • Page 40
    ... interest rate swap contracts, we make fixed-rate interest payments and receive interest payments based on LIBOR. The effect of these swaps is to convert fixed-rate returns to floating-rate returns based on LIBOR for a portion of our fixed income portfolio. The gains and losses related to changes...

  • Page 41
    ... portfolio. To manage our exposure to changes in the fair value of certain equity securities, we may enter into equity derivatives, including forward sale and option agreements. As of July 26, 2008, we have entered into forward sale agreements on certain publicly traded equity securities designated...

  • Page 42
    ... Total current assets Property and equipment, net Goodwill Purchased intangible assets, net Other assets TOTAL ASSETS LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt Accounts payable Income taxes payable Accrued compensation Deferred revenue Other current...

  • Page 43
    ..., 2008 July 28, 2007 July 29, 2006 NET SALES: Product Service Total net sales COST OF SALES: Product Service Total cost of sales GROSS MARGIN OPERATING EXPENSES: Research and development Sales and marketing General and administrative Amortization of purchased intangible assets In-process research...

  • Page 44
    ...income taxes Excess tax benefits from share-based compensation In-process research and development Net gains and impairment charges on investments Other Change in operating assets and liabilities, net of effects of acquisitions: Accounts receivable Inventories Lease receivables, net Accounts payable...

  • Page 45
    ... Repurchase of common stock Tax benefits from employee stock incentive plans Purchase acquisitions Employee share-based compensation expense Share-based compensation expense related to acquisitions and investments BALANCE AT JULY 26, 2008 6,331 - - - $ 22,394 - - - $ 506 5,580 - - $ 274 - (63...

  • Page 46
    ... conditions that may affect a customer's ability to pay. (e) Financing Receivables and Guarantees The Company provides financing arrangements, including leases, financed service contracts, and loans, for certain qualified customers to build, maintain, and upgrade their networks. Lease receivables...

  • Page 47
    ... financed service contracts also approximate the carrying amount. The fair values of fixed income investments, publicly traded equity securities, and the Company's long-term debt are determined using quoted market prices for those securities or similar financial instruments. 52 Cisco Systems, Inc...

  • Page 48
    ... and retail partners participate in various cooperative marketing and other programs, and the Company maintains estimated accruals and allowances for these programs. The Company accrues for warranty costs, sales returns, and other allowances based on its historical experience. 2008 Annual Report 53

  • Page 49
    ... employee stock options and employee stock purchases related to the Employee Stock Purchase Plan ("employee stock purchase rights") based on estimated fair values. SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing...

  • Page 50
    ...using the weighted-average number of common shares and dilutive potential common shares outstanding during the period. Dilutive potential common shares primarily consist of employee stock options, restricted stock and restricted stock units. Statement of Financial Accounting Standards (SFAS) No. 128...

  • Page 51
    ... at their acquisition-date fair values with subsequent changes recognized in earnings; and requires in-process research and development to be capitalized at fair value as an indefinite-lived intangible asset. SFAS 160 will change the accounting and reporting for minority interests, reporting them as...

  • Page 52
    Notes to Consolidated Financial Statements 3. Business Combinations (a) Purchase Acquisitions Under the terms of the definitive agreements related to the Company's purchase acquisitions and asset purchases completed during fiscal 2008, 2007, and 2006, the purchase consideration consisted of one or ...

  • Page 53
    ... products for the consumer. • The Company acquired Scientific-Atlanta, Inc. to create an end-to-end solution for carrier networks and the digital home and deliver large-scale video systems to extend Cisco's commitment to and leadership in the service provider market. • The Company acquired...

  • Page 54
    ... results of operations during February 2006. In addition, the pro forma financial information also included the purchase accounting adjustments on historical Scientific-Atlanta inventory, adjustments to depreciation on acquired property and equipment, a charge for in-process research and development...

  • Page 55
    ... Purchased Intangible Assets (a) Goodwill The following tables present the changes in goodwill allocated to the Company's reportable segments during fiscal 2008 and 2007 (in millions): Balance at July 28, 2007 Balance at July 26, 2008 Acquisitions Other United States and Canada European Markets...

  • Page 56
    Notes to Consolidated Financial Statements The following tables present details of the Company's purchased intangible assets (in millions): July 26, 2008 Gross Accumulated Amortization Net Technology (1) Customer relationships Other Total $ 1,785 1,821 247 $ 3,853 $ (905) (674) (185) $ (1,764) ...

  • Page 57
    ...and related software Production, engineering, and other equipment Operating lease assets Furniture and fixtures Less accumulated depreciation and amortization Total Other assets: Deferred tax assets Investments in privately held companies Income tax receivable Lease receivables, net Financed service...

  • Page 58
    ..., net Reported as: Current Noncurrent Loan receivables, net $ 607 (128) $ 479 $ 263 216 $ 479 $ 513 (243) $ 270 $ 198 72 $ 270 A portion of the revenue related to loan receivables is deferred and included in deferred product revenue based on revenue recognition criteria. 2008 Annual Report 63

  • Page 59
    ... to Consolidated Financial Statements (d) Financing Guarantees The Company provides financing guarantees, which are generally for various third-party financing arrangements extended to channel partners and other customers. The Company could be called upon to make payment under these guarantees in...

  • Page 60
    ... losses related to fixed income securities as of July 26, 2008 were primarily due to changes in interest rates and credit market conditions. The gross unrealized losses related to publicly traded equity securities as of July 26, 2008 were due to changes in market prices. The Company's management has...

  • Page 61
    ... Federal Funds rate plus 0.50% or Bank of America's "prime rate" as announced from time to time, or (ii) LIBOR plus a margin that is based on the Company's senior debt credit ratings as published by Standard & Poor's Ratings Services and Moody's Investors Service, Inc. The credit agreement requires...

  • Page 62
    ... functional currency of the reporting entity. The Company's foreign exchange forward contracts related to current assets and liabilities generally range from one to three months in original maturity. Additionally, the Company has entered into foreign exchange forward contracts with maturities of up...

  • Page 63
    ... rate swap contracts, the Company makes fixed-rate interest payments and receives interest payments based on LIBOR. The effect of these swaps is to convert fixed-rate returns to floating-rate returns based on LIBOR for a portion of the Company's fixed income portfolio. The gains and losses related...

  • Page 64
    ... manufacturing services for its products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, the Company enters into agreements with contract manufacturers and suppliers that either allow them to procure inventory based upon...

  • Page 65
    ... for warranties issued Payments Fair value of warranty liability acquired Balance at end of fiscal year $ 340 511 (455) 3 $ 399 $ 309 510 (479) - $ 340 The Company accrues for warranty costs as part of its cost of sales based on associated material product costs, labor costs for technical support...

  • Page 66
    ...of employee tax withholding obligations due upon the vesting of restricted stock or stock units. (c) Preferred Stock Under the terms of the Company's Articles of Incorporation, the Board of Directors may determine the rights, preferences, and terms of the Company's authorized but unissued shares of...

  • Page 67
    ... Cisco Systems, Inc. WebEx Acquisition Long-Term Incentive Plan (the "WebEx Acquisition Plan"). In addition, the Company has, in connection with the acquisitions of various companies, assumed the share-based awards granted under stock incentive plans of the acquired companies or issued share-based...

  • Page 68
    ... grant of stock options, stock, stock units, and stock appreciation rights to certain employees of the Company and its subsidiaries and affiliates who had been employed by Scientific-Atlanta or its subsidiaries or WebEx or its subsidiaries, as applicable. As a result of the shareholder approval of...

  • Page 69
    ... Financial Statements General Share-Based Award Information A summary of share-based award activity is as follows (in millions, except per-share amounts): STOCK OPTIONS OUTSTANDING Share-Based Awards Available for Grant WeightedAverage Exercise Price per Share Number Outstanding BALANCE...

  • Page 70
    ..., stock purchase rights, restricted stock, and restricted stock units granted to employees. The following table summarizes employee share-based compensation expense (in millions): Years Ended July 26, 2008 July 28, 2007 July 29, 2006 Cost of sales-product Cost of sales-service Employee share-based...

  • Page 71
    ...of future stock price trends than historical volatility. • The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of the Company's employee stock options and employee stock purchase rights. • The dividend yield assumption is based on the history and...

  • Page 72
    ..., 2008 and was recorded in long-term liabilities. (e) Defined Benefit Plans Assumed from Scientific-Atlanta Upon completion of the acquisition of Scientific-Atlanta, the Company assumed certain defined benefit plans related to employee pensions. Scientific-Atlanta had a defined benefit pension plan...

  • Page 73
    ... a tax benefit of approximately $60 million related to the U.S. federal R&D tax credit attributable to fiscal 2006 R&D. The tax provision for fiscal 2006 included a benefit of approximately $124 million from the favorable settlement of a tax audit in a foreign jurisdiction. 78 Cisco Systems, Inc...

  • Page 74
    ... foreign subsidiaries in operations outside the United States. As a result of certain employment and capital investment actions and commitments, the Company's income in certain countries is subject to reduced tax rates and in some cases is wholly exempt from tax. These tax incentives expire in whole...

  • Page 75
    ...for doubtful accounts and returns Sales-type and direct-financing leases Inventory write-downs and capitalization Investment provisions In-process R&D, goodwill, and purchased intangible assets Deferred revenue Credits and net operating loss carryforwards SFAS 123(R) share-based compensation expense...

  • Page 76
    ...Segment Information and Major Customers The Company's operations involve the design, development, manufacturing, marketing, and technical support of networking and other products and services related to the communications and information technology industry. Cisco products include routers, switches...

  • Page 77
    ... its products and technologies as advanced technologies. As of July 26, 2008, the Company had identified the following advanced technologies for particular focus: application networking services, home networking, security, storage area networking, unified communications, video systems, and wireless...

  • Page 78
    ...,681 $ 8,184 $ 5,233 $ 1,608 $ 0.27 $ 0.26 $ 19,520 Stock Market Information Cisco common stock is traded on the NASDAQ Global Select Market under the symbol CSCO. The following table lists the high and low sales prices for each period indicated: 2008 Fiscal High Low High 2007 Low First quarter...

  • Page 79
    ... stock trades on the NASDAQ Global Select Market under the ticker symbol CSCO. Investor Relations For further information about Cisco, additional copies of this report, Form 10-K, or other financial information without charge, contact: Investor Relations Cisco Systems, Inc. 170 West Tasman Drive San...

  • Page 80
    ... (IP)-based networking technologies. This tradition continues with the development of routing, switching, and other technologies such as application networking services, home networking, security, storage area networking, TelePresence systems, unified communications, video systems, and wireless...

  • Page 81
    Worldwide Offices Americas Headquarters San Jose, California, USA Asia Pacific Headquarters Singapore Europe Headquarters Amsterdam, Netherlands Cisco has more than 200 offices worldwide. Addresses, phone numbers, and fax numbers are listed on the Cisco website at www.cisco.com/go/offices. Printed...